2023-04-18 07:01:00 ET
Summary
- I've written about Alexandria Real Estate before, and called it a bit of an outlier in the office REIT space - because it really is quite different from office peers.
- As part of my strategy going forward, I'm focusing much more on quality and upside than income and yield - Alexandria goes hand-in-hand with this approach.
- I've recently added more ARE - I believe this REIT should be a priority for you - and here's why.
This article was coproduced with Wolf Report.
It hasn't in fact been all that long since I last covered Alexandria Real Estate ( ARE ) - however, I believe this company marks one of the lower-risk, more undervalued, higher-upside office REITs out there - and I don't see enough investors giving this company the attention I believe it deserves.
So, for that reason, I'm going to dedicate this article to telling you why I believe this should be at the top of your REIT investment list, and why I've increased my stake by over 100% in the last two months.
There's a lot to like about this REIT - and here's a reminder and an updated upside.
Alexandria - Probably the safest Office REIT upside out there.
So, despite office REITs being out of favor, Alexandria is in the position of being the least undervalued office REIT on our coverage spectrum. At a target of $170, the REIT is less than 30% undervalued. So why would I be interested in the least undervalued Strong-buy Office REIT (not spec buy) on our list?
Simple, quality.
Alexandria is BBB+ rated, and unlike other Office REITs focuses on a subsection of properties and developments which by many investors are considered to be higher quality overall compared to what else is available.
It might even be wrong to call Alexandria an "office REIT" to begin with. They do, technically, offer their customers "offices," but those offices are so different from your standard office landscapes that they should be likened more to specialized research, production, or workspaces.
Such spaces, used in sectors like pharma and healthcare, have entirely different demands than a standard brick office building, and this means that the volume/availability is lower, and the rent terms are usually far longer.
Instead of calling ARE an office REIT, we might want to call it a "healthcare/pharma REIT," which is somewhat weird, but probably more accurate.
Despite massively dropping from its premium levels of valuation, Alexandria showcases some impressive long-term returns.
Alexandria has one of the better balance sheets in the industry with more than $5.3B in liquidity available. Over 99% of the company's debt is fixed, the average interest rate is less than 3.6%, the leverage is less than 5.2x, and the company's average remaining debt term is longer than 13 years.
Maturities? None until 2025.
The company's portfolio is an exercise in, as I believe it, recession-resistant tenants found in properties that are hard to duplicate. This includes things like Biotech (clinical and post-clinical stages), institutional clients from both the public and private sectors, private biotech, life science, and multinational pharma.
Over 90% of the company's annual rent revenue is from IG-rated tenants or public/large cap tenants, and the company managed an 80%-plus retention rate over the past five years.
You might expect leasing activity to be low in 2022 and 2023, but 2022 was the second-highest leasing activity in the company's history - more than twice the 4.4M of 2020 in terms of annual leasing revenues in square footage. Over the past 10 years, ARE has managed 1.3M RSF per quarter, and in 1Q23, that number is still at 2.0M.
Not only that, the company has managed to increase its rental rates by a much higher pace than the overall market - and the fourth-highest in all of ARE history.
The current low valuation means the company's yield is well above its average, which is around 3%, compared to the current 4%. Despite increased interest rates and troubles faced by REITs, ARE is expected to continue to grow at an impressive pace of 6-8% FFO growth per year on average going forward until 2025E.
The company also is an expert manager in terms of dispositions and sales. The company, during 2022, sold at a $1.2B gain at an average 4.5% cap rate. With the company's war chest filled for 2023, ARE is in an excellent position to keep growing - that's why the company has increased its LoC as well as its terms. Also, remember, ARE managed to issue bonds at 3.28% at an average term of 22 years, which tells you something about the risk the market sees with this company.
The current ARE leverage is the lowest in company history.
So, let me reiterate that I try to find companies, including REITs, that do things better than their peers. And while I invest in peers of ARE, such as Boston Properties ( BXP ), Kilroy ( KRC ), and Highwoods ( HIW ), as well as other REITs, I see Alexandria as having a significantly different risk profile - in a good way, not a bad one.
The picture that I want to give you with ARE is that the company is a class-leading sort of office REIT, but isn't really an office REIT based on the properties they offer.
The reason I want to own ARE, the reason I own ARE, and more importantly, the reason I now "BUY" more ARE, is because the company excels at what it does.
Even compared to companies that I typically cover, this one is better and safer - but it's also usually far more expensive. Even if you can't get the 6-8% of some of these other office REITs in terms of yield, you're getting the safety described above - and going forward, I put safety at a higher importance than income/yield.
Do we have to choose?
Not all the time - but I believe we do have to choose in some sectors and between certain companies. If you follow my work, even this week in some of the companies in basic materials/industrials, you'll note that I'm divesting or rotating companies with a higher/more volatile risk profile into investments with a lower risk profile, and often times lower yield. This is a conscious trade-off I am making.
I'm not going to stop investing in some of ARE's peers - such as BXP, HIW, and KRC - but the relative amount of invested capital is higher in ARE than these others.
It doesn't change my goals or requirements - I still want cheap, above-quality companies with yield and a combined upside of over 10%-12% per year , but in choosing between companies A and B, I believe it's time to err on the side of safety.
Alexandria Real Estate - Safer choice, even in valuation
So, as I mentioned, ARE is BBB+ rated. The company's current stock movement in no way reflects the operational results or risk profile. ARE is still a 20B+ company with an EV of almost $35B. In terms of its NAV, the current share price comes to less than 0.65x.
Since 2010, the average for this has been at about 0.97x, a high of 1.27x, and a low of 0.63x. This alone should tell you something about how the company is currently being valued by the market in terms of its historicals.
It's important to mention that ARE has traded at a high premium for several years. Since 2015, the typical P/FFO has been above 16x, and sometimes as high as 28-29x P/FFO. I do not view this as justifiable, not even with the company's safety. We have a 15-year average of 7% FFO growth. The company isn't at sub-10x as some REITs are, but trading below 14x.
That means, even expecting only 15x P/FFO, which is lower than we've seen the company trade for over eight years , the upside still looks like this.
Now, this is the bearish case , not even the base case. Even with interest rate pressures, I believe this company should warrant a higher valuation based on its fundamental qualities - at least 0.8x NAV, which currently comes to about $145. As you can see, at iREIT we value the company even higher. $145/share isn't even a 15x 2025E P/FFO - so again, conservative.
Any potential reversal to the valuation ranges of the past decade brings with it the potential for 19%-30% annualized upside. Compare the 4.1% yield with what you can get from a savings account or an MMF, and you're still coming away with a similar (and potentially growing) income, and an additional 10%-15% upside from capital appreciation, if some of this upside materializes.
The bullish case calls for a 19-22x P/FFO normalization, and the result looks something like this.
That's almost triple digits - and I don't see it as particularly unrealistic here.
We rate ARE a "strong buy" with a PT of $170/share, which gives us a significant upside. The company is down nearly 40% in about a single year - something I view as a very welcome change compared to where this company typically is. We can actually buy this excellent REIT at what I would say most analysts would say is an undervaluation.
Other analysts follow the company - 10 of them in fact - and 9 of them are either at a "BUY" or "Outperform" at this time, with a PT range starting at $140 and going up to $198 with an average of $173.9/share, above the iREIT on Alpha target. So, at iREIT, we're even more conservative than the average investor.
There still isn't a single perspective or argument that I can see, of a valid argument that this company will not produce positive returns going forward for the medium term.
In fact, it would take something massively detrimental, something truly cataclysmic to change this company from a "buy" to something else at this point - and since my last article, my conviction of this has only grown stronger.
Now, if you believe that investors with substantial resources, such as billionaires and their funds, have certain knowledge, you'll also notice that the funds like those of Ray Dalio, Jeremy Grantham, Joel Greenblatt and other investors you might have heard of, are adding shares or holding a position in the company. (Source: GuruFocus)
Risks and bearish-side considerations?
Most of the bearish considerations have to do with the fact that ARE is trading at a significant premium to its office REIT peers. I might have considered this criticism valid at one time, but ARE is now trading at close to 13.5x P/FFO. Relative to their massively discounted but somewhat riskier office REIT peers, that's still a difference, but I don't see anything below 20x P/FFO as valid even in this environment. Occupancy is close to 95% at this time, showcasing some of this quality.
My own cost basis for this company is below $125/share, and I intend to push this down further by investing in ARE in the coming week.
Here's my updated thesis for the company, and why I'm even less worried about this company than I am about high-quality office companies like the other three peers mentioned.
Thesis
- Alexandria Real Estate is a class-leading REIT in the office sector, though I would argue it is far better than your average office REIT, including some of the "best" ones that I invest in, such as BXP, HIW, and KRC.
- This company is undervalued very rarely - so when it is, this warrants immediate highlighting - which is exactly what I am doing here.
- I give ARE a "BUY" with a $165/share PT, which comes to a very conservative 20x P/FFO on a forward basis.
- I'm buying more ARE in the coming week.
Remember, I'm all about:
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating No. 1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them ( italicized ).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
This means that the company fulfills every single one of my criteria, making it relatively clear why I view it as a "buy" here.
Author's note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.
For further details see:
Alexandria Real Estate: High Conviction Buy